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Management PolicyRisk Information

The main risk factors for the GungHo Group’s business development are described below. To make information more useful for investors, the Group discloses items that are considered to be important for decision making by investors, including uncontrollable external factors and items that do not necessarily have high possibility of occurrence. The Group’s policy is to avoid and address these risks by understanding the probabilities of occurrence. However, the Company considers that it is important for investors to carefully consider the items described below and other descriptions in this document when making a judgment on the Group’s business conditions and future businesses when investing in the Company’s shares. Furthermore, the following descriptions may not cover all risks related to investments in the Company’s shares.
This paragraph contains certain future-related matters that are considered valid as of March 24, 2017, and are subject to inherent uncertainty. As a result, actual results may differ from those forecasted.

1.Business risks of the GungHo Group

a.Dependence on a specific game

(i) Dependence on sales of certain games

The ratio of “Puzzle & Dragons”-related sales to net sales of the GungHo Group has increased significantly since 2012. The Group currently offers related products to a wide range of users, including games for smartphones and Nintendo 3DSTM and character goods. The ratio of sales of these products to net sales was 88.6% for the fiscal year ended December 31, 2015 and 84.3% for the fiscal year ended December 31, 2016. This means that the Group is dependent on sales of this game. Accordingly, if the competitive advantage of “Puzzle &anmp; Dragons” deteriorates due to the release of competing games, etc. by competitors, the Group’s operating results and future business development may be affected.

(ii) Retaining and increasing the number of Monthly Active Users (MAU)

The Group manages MAU of “Puzzle & Dragons” and other games as a key performance indicator, because it considers that it can create a long-lasting game brand and generate more revenue by retaining and increasing the number of MAU. To retain and increase the number of MAU, the Group implements various measures such as in-game events and campaigns. However, these measures may not be appreciated by users, and the number of MAU may decline. In such case, the Group’s operating results and future business development may be affected.

b.Incurrence of development costs

The Group may incur substantial costs to develop its original games in the long run before their releases.
In addition, it is likely to take a long time to recoup investment costs after starting to provide services. Accordingly, the Group needs to establish a financial base that can withstand payments of substantial development costs.
With technological development in the future, new smartphones, game consoles, and other devices from each manufacture are expected to be of higher performance. Accordingly, game development costs may increase. As a result, the Group’s operating results and future business development may be affected.

c.Development and sales of new games, etc.

As a business growth strategy, the Group considers it is important to create original killer content.
When developing new games, the Group follows five development principles to provide a “fun” experience. However, although development of new games requires a lot of time and funds, there is no guarantee that they will always be appreciated by users due to changes in their preferences. Accordingly, the Group may delay or suspend development of new games. As a result, the Group’s operating results and future business development may be affected.

d.Global business development

In order to continue achieving mid- to long-term growth, the Group will pursue global business development of its smartphone games, online PC games, and consumer games independently or in collaboration with overseas partners.
However, global business development is subject to various inherent country risks such as social conditions, politics, economy, culture, religion, laws, systems, and regulations in individual countries. As a result, if these risks become apparent, the Group’s operating results and future business development may be affected.

e.Foreign exchange risk

The Company has overseas consolidated subsidiaries (e.g. GRAVITY Co., Ltd. in Korea, GungHo Online Entertainment America, Inc. in the U.S and GungHo Online Entertainment Asia Pacific Pte.Ltd. in Singapore).
Financial statements of overseas subsidiaries are translated into yen when preparing consolidated financial statements. Accordingly, if foreign exchange rates fluctuate significantly, the Group’s operating results may be affected. The Group also conducts foreign currency-based transactions to collect sales proceeds and pay fees associated with the provision of games.
As a result, if foreign exchange rates fluctuate significantly, the Group’s operating results and future business development may be affected.

f.Risk of failing to successfully implement management strategies

In the game industry, where the Group conducts business, game product life cycles tend to be shorter as a whole. Accordingly, the Company’s most important management strategy is to enhance the value of current games and maximize existing value so that they can become long-lived brands. The Company also aims to improve its core products (i.e. games) and ensure multifaceted business development by implementing various measures including distribution of goods, cartoons, etc. as well as hosting real-life events such as GungHo Festival so that game fans including potential ones can enjoy gaming. However, if the Company’s management strategies may not work as planned, the Group’s operating results and future business development may be affected.

g.Ensuring the appropriateness of expressions used in games

To ensure the appropriateness of expressions used in games, the Group sets certain criteria during the process of developing and distributing games before starting to provide services. Under these criteria, it is basically disallowed to use descriptions and expressions that may arouse extremely violent and sexual emotions for young audiences, but if the provision of games by the Group is regulated or affected due to the future enactment and enforcement of stricter laws and regulations, the Group’s operating results and future business development may be affected.

2.Risk related to business environment surrounding the Group

a.Increasing competition

While technological innovation progresses rapidly and user needs become more diverse, the number of companies supplying entertainment via the Internet, as well as game titles, is steadily increasing. Under these circumstances, the Group takes advantage of its experiences and knowhow in planning, development, and operations related to online PC gaming services it has offered for more than 10 years, to enhance user satisfaction further on services provided on various devices. However, upon the occurrence of an event that the Company does not anticipate (e.g. a sharp rise in advertising expenses due to stiffer competition for advertising spots as a result of increasingly fierce competition to acquire users, or a deterioration of the Company’s competitive advantages due to the emergence of competitors), the Group’s operating results and future business development may be affected.

b.Responding to user preferences

Because users to whom the Group provides games are general consumers, user acquisition may be affected by user preferences, which change with the passage of time. Accordingly, if the Group cannot provide games in line with user preferences, the Group’s operating results and future business development may be affected.

c.Responding to damage caused by harmful rumors and user requests

The Group is engaged in planning, developing, distributing, operating, and sales of online games for smartphones, PCs, and home game consoles, and users of games provided by the Group tend to frequently access information exchanged on the Internet.
Due to the nature of the Internet, a variety of information is exchanged irrespective of whether or not it is true. Accordingly, games that the Group provides are susceptible to damage caused by harmful rumors on the Internet in particular. As a result, the Group has tried to extensively collect the opinions of users and enhance customer satisfaction by improving Web Help Desk functions (i.e. customer support functions). However, if it becomes difficult for the Group to respond to harmful rumors and user requests, the Group’s operating results and future business development may be affected.

d.Responding to technological innovation

The online game market, in which the Group conducts its business, is closely related to computer technologies, including those related to networks and server operations, and one of the characteristics of these technologies is significant technological innovation. The Group’s policy is to respond to the progress of computer technologies in a timely manner, but the Group may not be able to catch up with the unanticipated progress of new technologies, etc., or may incur higher costs to respond to such progress. Given this situation, the Group’s operating results and future business development may be affected.

e.Intellectual property rights

The Group has registered trademark rights for its corporate name, game names such as “Puzzle & Dragons,” and others. The Group also files patent applications in a timely manner for its in-house developed gaming technologies, etc., which are considered to be important for business operations. The Group has established a structure to acquire and manage intellectual property rights, and also examines whether it infringes such rights of third parties to the extent possible. However, it is impossible to completely eliminate the possibility of infringing other parties’ intellectual property rights in connection with services of the Group and other cooperative services offered by third parties.In addition, the Group provides some of its games under licensing agreements with third parties that hold intellectual property rights, and handles such rights particularly carefully so that it does not infringe their rights. The Group examines these rights, etc. using the Patent Office Database with the support of patent agents and attorneys at law who are involved from the initial phase of a proposed license acquisition. The Group makes contracts with licensers carefully so that it can safely conduct its business operations. For example, warranty against infringement of other parties’ rights and relevant responsibilities are included in contract provisions. However, there is no guarantee that the range of examinations the Group conducts is sufficient and reasonable. In addition, it is difficult to accurately anticipate the ways in which all intellectual property rights such as patent rights are used in the Group’s business. If the Group should infringe other parties’ intellectual property rights, those parties may litigate, forcing the Group to pay compensation for damage, stop using such rights, or pay a consideration for them. In such cases, the Group’s operating results and future business development may be affected.As of the end of the fiscal year ended December 31, 2016, the Group was not a defendant in any lawsuit for infringing intellectual property rights.

f.System trouble

The Group provides its online games via the Internet. Accordingly, if the system goes down due to an unpredictable cause (e.g. a natural disaster such as an earthquake, regional disaster such as fire, computer virus, power supply stoppage, telecommunication malfunction, and suspension or stoppage of services caused by a telecommunications carrier), the Group will not be able to continue operations. In addition, if the server of the Group or its data center becomes inoperative due to a tentative overload caused by a surge in the number of accesses, malfunctions, or similar cause, the system may stop operating. In addition, game data the Group provides may be rewritten or important data may be lost or stolen due to criminal acts such as unlawful computer intrusion by third parties, mistakes of executives and employees, or other reasons.
To prevent these events, the Group has established structures focusing on safety, including a security-oriented system structure, diversification of network loads, and 24-hour monitoring systems. In addition, if the Group finds bugs in its online games, it suspends or stops the provision of gaming services, explores causes, and conducts restoration work.
If a large-scale system problem occurs despite such measures, the Group may directly incur damage or the reliability of its system itself may be adversely affected. As a result, the Group’s operating results and future business development may be affected.

g.Risks related to M&A, etc.

To strengthen overseas business development, etc., the Group has expanded business by establishing overseas subsidiaries, acquiring companies whose business operations are closely related to those of the Group (e.g. M&As), and by other means. Despite the establishment of those subsidiaries, acquisitions, etc., the Group is still subject to the risk of incurring losses caused by a failure to generate initially assumed effects. In addition, the entire Group’s credibility may deteriorate depending on the financial conditions and operating results of investee companies. In such cases, the Group’s financial conditions, operating results, and future business development may be affected.

h.Charge-related problems with smartphone users

Smartphone users belong to a wide range of age groups. The number of middle and high school game users has been increasing recently, and more minors are also enjoying games using their family members’ devices, even if they do not have their own smartphones. The Group sells certain items through its smartphone games, and offers various methods of payment for the purchase of those items, such as credit card settlement, telecommunications carrier billing, and prepaid card settlement. Charge-related problems have recently occurred in connection with credit card settlements using family members’ devices in particular. For example, minors have mistakenly purchased items, etc. and received billing notifications to pay large fees. The Group has created a sound market environment by exchanging information with regional consumer affairs centers and the Consumer Affairs Agency. However, if new regulations associated with occurrence or increase of troubles that the Group does not anticipate are enacted, the Group’s operating results and future business development may be affected.

i.Movements of Apple Inc. and Google Inc.

The ratio of sales of smartphone games to the Group’s net sales is increasing. Accordingly, the Group depends more on fee collection services provided by payment agencies (platformers) such as Apple Inc. and Google Inc., and also on operations using platform and other systems. The Group has trusting relationships with these platformers. However, if the Group becomes unable to continuously fulfill contracts with them for some reason, or if fee rates, etc. change due to revised platform business strategies or relevant movements, the Group’s operating results and future business development may be affected.

3.Legal regulations

a.Protection of personal information

For certain games it provides, the Group keeps personal information on its server because such information is required for member registration, game usage registration, and billing. The “Act on the Protection of Personal Information” (the Ministry of Economy, Trade and Industry) has taken effect, for example. As a result, companies are increasingly forced to protect personal information more strictly.
To prevent the leakage, improper usage, manipulation, etc. of personal information, the Group actively protects personal information. The Group considers that personal information management is important for its business operations. For example, the Group has set up rules, etc. for protecting and handling customers’ personal information, strictly managed it by creating operational flows covering the treatment of personal information, offered comprehensive in-house training for all employees, and sought to comply with the said Act, relevant laws, and guidelines applicable to the Group.
In addition, the Group attempts to avoid leaks of personal information. For users of GungHo games, the Group has managed personal information by classifying it into two original categories (i.e. GungHo ID and Attraction ID), so that it can physically segregate important personal information and prevent access to such information from outside the Group. The Group has also implemented measures to allow only authorized personnel to gain access to personal information.
However, if personal information-related problems occur, such as leakage, manipulation, and unlawful use, the Group may incur considerable costs to resolve them and receive claims for damage. In addition, the Group’s credibility may deteriorate. As a result, the Group’s operating results and future business development may be affected.

b.Legal regulations related to the Internet

Online game services the Group provides are subject to various legal regulations, etc. related to the Internet.
The Company complies with these legal regulations. However, if an administrative disposition, etc. should be issued to the Company due to the violation of the said regulations, etc., or the Company’s business is restricted in the future due to the strengthening of these laws, etc. or the enactment of new laws, etc., the Group’s operating results and future business development may be affected.

c.Legal regulations related to smartphone games

According to an opinion of the Consumer Affairs Agency issued in July 2012 in relation to the smartphone game industry to which the Group belongs, game systems that excessively induce speculation have recently become a major problem, and the charge system called “Complete Gacha (see Note)” is in violation of the “Act against Unjustifiable Premiums and Misleading Representations.”
The Group has voluntarily responded to this issue, adopted “Display and Operation Guideline for Item Sales that Use the Random-model Item Provision Method” issued by Japan Online Game Association (hereafter JOGA), and attempted to create a safe environment that can offer peace of mind from the standpoint of protecting consumers and complying with various laws. In addition, “Act on Settlement” and various tax laws including the consumption tax law are applicable to the Group’s charge system for smartphone games.
In the provision of services, the Group complies with laws as a matter of course, exchanges information with the industry association, etc. in which the Group participates, and also incorporates the opinions of such association, etc. in its activities.
However, if new legal regulations are enacted due to future changes in social circumstances, including a revised interpretation of existing laws, etc., the Group’s business may be particularly restricted, and its operating results and future business development may be affected.
(Note) Complete Gacha is a system under which users can get rare items and cards by randomly gathering a certain number of items and cards.

d.Risks related to Real Money Trade (“RMT”)

Conduct called “Real Money Trade (“RMT”)” has been observed in the online game industry. RMT means the trading of intra-game items or user IDs among users on auction sites, etc. The Group has set up a user policy to clearly prohibit this act, and has also implemented strict measures (e.g. compulsory termination of violators’ memberships) so that it can monitor auction sites, etc. in a timely manner. However, if an unexpected event occurs, such as RMT conducted on a large scale for games the Group provides, the reliability of the Group’s services may decline, and the Group’s operating results and future business development may be affected.

4.The Company’s business structure

a.Dependence on Kazuki Morishita, Representative Director, President and CEO

The Group’s business driver is Kazuki Morishita, Representative Director, President, and CEO. Since joining the Company in May 2001, Kazuki Morishita has been involved in launching online gaming services, and has contributed to hit titles for the Company. For example, he discovered “Ragnarok Online,” the Company’s main online PC game, in Korea, obtaining distribution rights for the game, and has also been executive producer of “Puzzle & Dragons” for smartphones in recent years. He also currently heads the entire process of developing new games ranging from planning to development and to compilation. Accordingly, the Group is considered to be highly dependent on him.
The Group is strengthening its organizational structure through the delegation of authority, personnel recruitment, etc. However, if he becomes unable to drive the Group’s business forward due to some reason, the Group’s operating results and future business development may be affected.

b.Securing personnel

To expand its business, the Group considers it important to secure capable personnel in various areas, such as system engineers for online games, game planners, game developers, and managers for other operations. However, due to rapid technological innovation, particularly in the online game industry, the absolute number of game engineers, planners, and developers who have experience in the online game business is small. As a result, the Group sees it a challenge to secure such capable personnel.
The Group’s policy is to continue to secure capable personnel. However, if it fails to secure or assign appropriate personnel in a timely manner, or loses personnel, the Group’s operating results and future business development may be affected.

c.Internal control system

The Group complies with domestic and overseas laws, rules, etc. by setting up legal compliance rules, etc. so that its personnel do not engage in misconduct. The Group has also established the internal audit section, an independent organization under the direct control of the president, and has confirmed the status of compliance with laws, rules, etc. to improve its internal control system.
However, if an unexpected event occurs, such as a legal violation and misconduct by group personnel, the Group’s operating results and future business development may be affected.